The things that you think CAUSE inflation are merely the symptoms of price stickiness

Some people liked my previous post, while some missed the point.  So let’s take another stab at it.

My island economy with 100,000 people and $1 billion dollars in Monopoly money does just fine for 273 years, with NGDP fluctuating above and below $8 billion as velocity moves around due to random minor shocks.  Then another crate of Monopoly money unexpectedly washes up on the beach, doubling the money supply to $2 billion.  The public is not stupid; they understand the implications of this monetary shock.  They know that prices will double in equilibrium, so they immediately start charging twice as much for the commodities they sell.

Is this “rational expectations” assumption realistic?  I think so.  I’m pretty sure than when the Mexican government does a 100 to 1 currency reform, an uneducated woman in Oaxaca selling strawberries to tourists will immediately cut the peso price of her strawberries by 99%, even though the Mexican government has no law requiring that lady to charge any particular price for strawberries.  (Someone correct me if I’m wrong.)

Now let’s say I am wrong about rational expectations and flexible prices.  Then what?  Let’s say the people who live in my island economy are a bit “slow” and don’t understand that the extra $1 billion in Monopoly money that washed up on the beach will soon cause the price level to double.  What then?  In that case you get an overheated economy, with excess demand.  The price level does not immediately double; rather it doubles over a period of weeks or months, as people eagerly spend their new wealth on goods and services.

Only an idiot (or a brilliant saltwater economist) would think that this excess demand is causing the inflation.  Indeed if there were no excess demand we’d be back in the currency reform case, where prices immediately double.  The excess demand resulting from sticky prices is actually slowing the upward adjustment in prices.  The inflation is clearly caused by a doubling of the money supply in both the rational expectations and the sticky price case, it’s just that with sticky prices it takes a bit longer to occur, and excess demand for goods is a side effect.  But it would be idiotic to claim that this excess demand causes the inflation.  It’s a symptom of price stickiness.

Now let’s add wage earners and sticky wages to our island economy.  After the crate washes up on the beach, firms eagerly produce more as demand for their goods rises and wages are temporarily fixed.  Hours worked increase.  But only an idiot (or a brilliant saltwater economist) would claim the tight labor market is causing the inflation.  If wages were not sticky and the labor market cleared then the inflation would actually happen even more rapidly, indeed it would happen immediately if both wages and prices were flexible and people had rational expectations.  Sticky wages slow the inflation process and lead to labor shortages.  Labor shortages are a symptom of sticky wages.

Now let’s add a financial market to the island economy.  After the crate of money washes up on the beach, the lucky islanders who first discover the crate have more money than they wish to hold.  They exchange this money for other assets, which depresses interest rates.  Of course eventually prices will double and then they really will be happy to hold twice as much cash as before.  Interest rates will return to normal.  But during the transition period the interest rate will fall, which depresses the velocity of circulation.  The reduced velocity slows inflation.  So money is not neutral in the short run.  But only an idiot (or a brilliant saltwater economist) would claim that the lower interest rates cause the inflation.  Indeed if interest rates did not decline and velocity stayed the same, then prices would rise much faster.  The tendency for interest rates and velocity to initially decline due to sticky prices actually slows the upward adjustment in prices.  It’s merely a symptom of price stickiness, not an underlying cause of inflation.  The inflation is caused by a doubling of the money supply. Lower interest rates are a symptom of sticky prices.

Look, I’m a market monetarist, not a new classical economist.  So obviously I think sticky wages and nominal debt contracts are really important.  But they are not important because they explain how money causes inflation—the flex-price classical model does just fine in that regard—they are important because they help us to understand all the nasty side effects from unstable money.  Those real world side effects are extremely important, far more important than the inflation itself.  (Hitler was a side effect of German tight money.)  But they are not the underlying cause of the inflation (or the NGDP growth), they are symptoms.  This makes excess demand/Phillips curve/interest rate theories of inflation doubly wrong.  Not only do these factors not cause inflation, to the extent they are important they actually slow the inflation process resulting from monetary shocks (shocks to the money supply or money demand).

PS.  People please read what I wrote, not what you think I wrote.  I never said saltwater economists were idiots, I said “idiot or a brilliant saltwater economist.”  These guys really are brilliant.  The word “or” has a very well defined meaning, please use the correct definition.

PPS.  Why did brilliant saltwater economists fall into the trap of confusing symptoms and causes?  First, because these symptoms often result from inflationary monetary shocks.  (Confusing correlation with causation).  And second, they are confusing demand shifts with “excess demand”.  Think about a microeconomic analogy.  If there is a shortage of bottled water in Florida after a hurricane, and water prices are gradually rising to equilibrium, the rising water prices are not caused by the shortage of water; indeed prices would be even higher if there were no excess demand.  The rising water prices are caused by more demand for water.

Similarly, inflation is caused by either more supply of money or less demand for money.  All the rest is symptoms.



57 Responses to “The things that you think CAUSE inflation are merely the symptoms of price stickiness”

  1. Gravatar of Joseph Joseph
    20. October 2017 at 09:26

    Note the main point of the post, but to your first two paragraphs, there’s an interesting paper by François R. Velde that looked fiat currency devaluations in 19th century France and found that commodity prices were slow to adjust. I find it interesting that the classic imagine a public doubling of the money supply, then prices instantaneously double example has an actual counterpoint historically.

  2. Gravatar of Patrick Sullivan Patrick Sullivan
    20. October 2017 at 09:28

    Scott, you might want to check in at the WSJ;

  3. Gravatar of Kevin Erdmann Kevin Erdmann
    20. October 2017 at 09:37

    Great post.

  4. Gravatar of John Hall John Hall
    20. October 2017 at 10:39

    Great post!

    Write a market monetarist book!

    Wrt Patrick Sullivan’s WSJ article, a well-known investment research service asked investors what the outlook for the dollar/equities/rates would be under different Fed chairs. Taylor was highest rates, highest dollar, lowest equities. Yellen was the reverse. I think these people are probably mistaken.

  5. Gravatar of Randomize Randomize
    20. October 2017 at 10:41


    I’m behind WSJ’s paywall but thought this might interest you. It shows that Taylor’s 1999 update would have put rates far below what the Fed adopted from the crisis through today.

  6. Gravatar of Steve F Steve F
    20. October 2017 at 11:55

    (1) Given your last line about how inflation can be caused by less demand for money, do you think that the Fed lowering the interest rate while not increasing the monetary base in 2007 — which you’ve said in the past created a money demand decline — was pushing up inflation?

    (2) Given your AD formula (M*V), does this mean that the lowered interest rate without increased money supply was increasing V?

    (3) I originally thought that the decline of money demand would be pushing down AD (or is it that AD decline pushes down money demand?), which would result in deflation. Could you explain what I’m getting wrong please?

  7. Gravatar of bill bill
    20. October 2017 at 13:14

    What if, on the day the second crate of money showed up, the Fed started paying IOR and the whole crate ended up at the Fed as excess reserves? And this made some brilliant saltwater economists even more certain about the impotence of monetary policy at the ZLB.

  8. Gravatar of Kenneth Duda Kenneth Duda
    20. October 2017 at 13:14

    Great post Scott. You make this seem so clear. Of course I was already convinced. But still, fantastic post.

  9. Gravatar of Gordon Gordon
    20. October 2017 at 13:28

    As a layman, I really enjoy seeing these kind of thought experiments. They demonstrate how the underlying fundamentals drive things.

  10. Gravatar of copans copans
    20. October 2017 at 13:30

    Echo-chambering the “Great Post” meme here. I’m going to have my 17-year-old read it tonight.

  11. Gravatar of Benoit Essiambre Benoit Essiambre
    20. October 2017 at 14:05

    This clears some things up. However, I am still not fully convinced.

    On scenario 1 ( 100 to 1 currency reform):
    >Is this “rational expectations” assumption realistic?

    With regards to the described situation, I think so, however there isn’t just a rational expectations assumption here. There is also an assumption of general knowledge about the change in money supply and its distribution, almost an assumption of money supply omniscience.

    On the second scenario (people in island economy are a bit “slow”):
    The definition of “a bit slow” is somewhat murky here. But in a lot of common scenarios, I would posit that actors simply do not know how much more money is sloshing around and only learn about it through market forces. Information propagation is a necessary step in the causal chain.

    >The excess demand resulting from sticky prices is actually slowing the upward adjustment in prices.

    To me it’s a lack of knowledge that is potentially slowing down price increases and it is the extra demand that is informing sellers of how much more money their buyers have and causing them to adjust prices upwards. If everybody knows how much more currency was permanently added and how it was distributed, prices should adjust fairly quickly. This is often not the case in complex economies.

    On the wage scenario, the wage stickiness is probably indeed slowing down inflation not causing it. But the scarcity of employees and abundance of customers having money does carry information about how much more money there is out there. The spread of this information is a precursor to price fully adjusting.

    Similarly with the last scenario the easy financing informs a lot of actors of how much more money is out there and causes them to hire employees and invest at increased prices.

    So I guess my arguments all come down to the changes in demand and change in interest rates being, for most actors, the main source of information on changes in money supply. The causal chain would go something like: More money -> changes in demand and interest rates making the change in money supply more visible and commonly known -> prices adjusting more generally.

    I agree that underlying the knowledge spread there is an actual increase of money but the way the knowledge propagates is worth mentioning and studying.

    Tangentially, I will also add that price stickiness is probably sufficient but, to me, doesn’t seem like a necessary condition for changes in money supply causing real changes in output. Output might be affected, even if everyone uses their own robots for production, if there are variations in desired aggregate consumption patterns through time such as with an uneven demographic like a baby boom. There could be rigidities in global energy production and limits in available natural resources and land, limits from the laws of physics. Tight money can cause the aggregate to under-invest, allocate insufficiently to storage capacity or durable things, and consume too much of their robots’ production immediately instead of storing it for when it’s more needed. Tight money may fool people into thinking that money will be able to buy all that they need later, when the necessary level of global production will be physically impossible regardless of there being no wages to adjust. There is something more fundamental to non neutrality of money than price stickiness, that of money and government paper crowding out required investment necessary for future consumption.

  12. Gravatar of AL AL
    20. October 2017 at 14:16

    I think of it this way: if you suddenly made everybody a millionaire, what happens to the price of a cheeseburger (and who makes it)?

  13. Gravatar of Major.Freedom Major.Freedom
    20. October 2017 at 14:26

    Undue price stickiness is CAUSED by inflation ya yokels. When everyone expects prices to increase every year because of counterfeiting, is it any surprise that there is a reluctance to decrease prices when that would be a good thing?

    Come on, the fact this is going ignored is ridiculous

  14. Gravatar of Matthew Waters Matthew Waters
    20. October 2017 at 14:40

    This post is kind of confusing. The island example assumes instant expectations, constant velocity, complete neutrality, etc.

    Then the slower adjustment case says “Demand drives up prices, but you’d be an ‘idiot’ to say demand drove up prices.”

    Sure, demand is an intermediate cause, but it is the direct cause. The ultimate causes of demand can be either M or V. M can be changed relatively directly, but V can change dramatically. Either V can go up dramatically for countries with currency crises or it can go down dramatically for banking panics.

    At some limiting state, the government can offset that. For currency crises, the government needs enough liquid assets to offset the run as well as increasing rates. For banking panics, full blown bank runs just take a lot to offset. In 2008, the Fed bailed out AIG, insured all money market funds, became the largest purchaser of commercial paper, and so on. All of that still wasn’t enough.

  15. Gravatar of Major.Freedom Major.Freedom
    20. October 2017 at 15:16

    I find it funny that Sumner is not touching on the fact that the stock market is rising like gangbusters. Stock market prices are always a reflection of expected FUTURE events.

    The Fed is raising rates by tightening up, and yet…

    Markets are wiser than Sumner

  16. Gravatar of Steve F Steve F
    20. October 2017 at 15:23

    Major Freedom,

    Do you not think that sticky prices emerge in part from agent aversion from seeing obvious wealth decreases? Wage cuts can do some real morale and productivity damage to the workplace and elsewhere.

  17. Gravatar of Sina Motamedi Sina Motamedi
    20. October 2017 at 16:08

    Scott, the last one was great, but this post is even better. Thanks.

    Please write a book.

  18. Gravatar of Philo Philo
    20. October 2017 at 18:59

    For the last two posts: a Nobel prize, even if you don’t write the book!

  19. Gravatar of Jerry Brown Jerry Brown
    20. October 2017 at 19:59

    “Some people liked my previous post, while some missed the point.”

    It must be nice in your world where people either agree with what you say or misunderstand it. Really nice. Nobody ever disagrees with the substance of what you say? They just can’t read?

    “Only an idiot (or a brilliant saltwater economist) would think that this excess demand is causing the inflation.”

    I am not an idiot, nor am I a ‘brilliant saltwater economist’ nor do I want to be one. But any writer who cannot recognize that people will conflate ‘idiot’ with ‘saltwater economist’ in that sentence is closer to idiot status than brilliant status.

    Perhaps you have an international audience for whom English is a second language so you think it necessary to point out what the word ‘or’ means in a PS. to the post. Aside from that possibility, it is mostly an insult to our intelligence.

    Your posts are much better when you recognize that people can have reasonable disagreements with what you say.

  20. Gravatar of ssumner ssumner
    20. October 2017 at 21:30

    Jerry, You said:

    “But any writer who cannot recognize that people will conflate ‘idiot’ with ‘saltwater economist’ in that sentence is closer to idiot status than brilliant status.”

    I agree, that’s why I added the PS.

    I knew that my readers include people like you.

  21. Gravatar of ssumner ssumner
    20. October 2017 at 21:33

    Matthew, You said:

    “This post is kind of confusing. The island example assumes instant expectations, constant velocity, complete neutrality, etc.”

    Read it again. I relaxed all of those assumptions, to see how things would change.

  22. Gravatar of dtoh dtoh
    20. October 2017 at 21:40

    So a couple of points, the first of which I’ve made before.

    1. The money washing up on the beach is not a good analogy for monetary policy or modern economies. Except for currency reform, monetary policy is not conducted that way. There are no helicopter drops. The issuance of money is always done through the extension of credit….or to be more accurate and generic, monetary policy is always effected through the exchange of money for financial assets between the financial sector (Fed plus commercial banks) and the non-financial sector.

    2. To respond though to your analogy of the monopoly money (or currency reform,) I agree. Inflation is not caused by excess demand…. it’s caused by an expectation of excess demand (or more accurately by an expectation of an imbalance of supply and demand.) If prices adjust quickly enough, no excess demand needs actually to occur. Your example perfectly illustrates this. There is zero uncertainty as to the expected effect of the new monopoly money, therefore prices adjust instantly and supply and demand remain in equilibrium albeit at a higher price level.

  23. Gravatar of Jerry Brown Jerry Brown
    20. October 2017 at 22:23

    Well- thanks for thinking of me when you write your posts. But it gets old quick when you continually say people misunderstand your writing. That is an excuse you can use here and there occasionally but use it too often and it seems like there is a problem with the writing- not the reading of it.

  24. Gravatar of mariorossi mariorossi
    21. October 2017 at 00:37

    I think the examples you make all assume exogenous changes in the supply and demand of money. While this is obviously true in many cases, I would imagine you could get endogenous changes in those variables.

    At that point supply and demand for money are just part of the system and discussing the source of any changes seems a bit pointless and a bit like discussing the beginning of a circle.

    Wouldn’t it be more accurate to state that a change in inflation is evidence of an imbalance in the supply and demand of money?

  25. Gravatar of Major.Freedom Major.Freedom
    21. October 2017 at 00:39

    Jerry Brown,

    What you said.


    Steve F:

    Just because people have become psychologically accustomed over multiple generations under inflation, where it is not clear observably how prices and production operate under a modicum of laissez faire, I.e. hampered market economy, it does not mean they will have that same psychology in a world of free market money, where production of goods and services as a rule outstrips the production of money, thus revealing a matrix of general price deflation.

    And laws ought not be based on emotion, but justice, I hope you know that. You are letting your fears dictate what you brain is able to rationally process.

  26. Gravatar of Major.Freedom Major.Freedom
    21. October 2017 at 00:44

    Steve F:

    More to your substantive point from which I think I get where you’re coming from,

    “Do you not think that sticky prices emerge in part from agent aversion from seeing obvious wealth decreases?”

    If a seller refuses to cut prices, other competing sellers can earn higher profits by cutting their prices.

    Profits, not prices, direct production.

    Your brain has melted after years of absorbing acid on this blog, which I often call a cesspool.

  27. Gravatar of Major.Freedom Major.Freedom
    21. October 2017 at 00:55

    See, the way a free market works is that falling output prices is accompanied by, indeed preceded by, falling input prices. When real capital accumulates, which is itself motivated by technological process and preceding capital accumulation, which in turn is by the way what the Keynesians who speak monetarist gibberish don’t really understand is the only way to grow economies, this lowers the prices of capital goods, which in turns lowers the input prices of all the firms that purchase them, which is all over.

    General price deflation is not inherently economically destructive. It is in fact part of any healthy free market economy.

  28. Gravatar of flow5 flow5
    21. October 2017 at 04:07

    Whether a new injection of money is inflationary depends upon various factors. One is that money is not matched in the marketplace by a corresponding offset of new goods and services.

    Only price increases generated by demand, irrespective of changes in supply, provide evidence of monetary inflation. There must be an increase in aggregate demand which can come about only as a consequence of an increase in the volume and/or transactions velocity of money. The volume of domestic money flows must expand sufficiently to push prices up, irrespective of the volume of financial transactions, the exchange value of the U.S. dollar, and the flow of goods and services into the market economy.

  29. Gravatar of flow5 flow5
    21. October 2017 at 04:10

    Vi (income velocity) is a seasonally mal-adjusted # (for both the money stock and N-gDp figures). And Vi includes the currency component (the same error as with the monetary base). If you remove currency, and use NSA #s, then you get an increase, the first in several years, in Vi beginning in the 2nd qtr. 2017. That explains a lot. The Trump bump has been resurrected.

    In the last 10 years, there’s been a huge shift in the volume and ratio of currency held by the non-bank public to commercial bank transaction based accounts (from .78% in 9/2007 to 1.39% in 8/2017). So if currency turns over slower than transactions based account balances (non-m1 components rate-of-turnover is negligible), then the Fed’s income velocity figures are understated. And RR’s underweight changes to Vt, as the seasonal pattern just signified.

    In the transactions velocity of circulation: “Money is spent and re-spent.” Whereas with income velocity, inflation analysis is delimited to wages and salaries spent. To the Keynesians, aggregate monetary demand is N-gDp, the demand for services (human) and final goods. This concept excludes the common sense conclusion that the inflation process begins at the beginning (with raw material prices and processing costs at all stages of production) and continues through to the end, (“raw materials, intermediate goods and labor costs, which comprise the bulk of business spending are not treated in N-gDp”), etc

    “There is a positive relationship between the currency ratio and income velocity”

    Bank debits reflect the ratio of transaction account payments to balances. “The hybrid and invalid nature of income velocity is affirmed by Keynes”: “A Treatise on Money”, New York, Harcourt Brace, 1930, vol. 2, pg. 24.

    “It is though we are to divide the passenger miles traveled in an hour by the passengers in trams, by the aggregate number of passengers in trams and trains and to call the result velocity.”

    “Quantity leads and velocity follows”. Cit. Dying of Money -By Jens O. Parsson

    P*T “≠” Milton Friedman’s Y.

    “Bank transactions are not limited to transactions in connection with current production…they reflect the sale of capital assets, income transfers, and money market dealings…”


    “A Federal Reserve survey, for example, that finds that physical currency turns over 55 times per year, i.e. about once a week.1”

    As the article states, cash is spent slower than transactions based bank deposits. And bank debits to transactions based accounts already count for some volume of cash transactions (duplicative) as it’s debited to those accounts for withdrawals in preparation for spending

  30. Gravatar of flow5 flow5
    21. October 2017 at 04:24

    Money flows, volume X’s velocity, is robust. Otherwise, there wouldn’t be distributed lags and concentrations in M*Vt. Since the distributed lag effect of money flows reflects mathematical constants for over 100 years, monetary policy, as Yale Professor Irving Fisher pontificated, should be an exact science.

    parse: dt; proxy for real-output, proxy for inflation

    01/1/2017 ,,,,, 0.13 ,,,,, 0.19
    02/1/2017 ,,,,, 0.08 ,,,,, 0.16
    03/1/2017 ,,,,, 0.06 ,,,,, 0.13
    04/1/2017 ,,,,, 0.08 ,,,,, 0.18
    05/1/2017 ,,,,, 0.09 ,,,,, 0.23
    06/1/2017 ,,,,, 0.08 ,,,,, 0.21
    07/1/2017 ,,,,, 0.11 ,,,,, 0.20
    08/1/2017 ,,,,, 0.09 ,,,,, 0.23
    09/1/2017 ,,,,, 0.08 ,,,,, 0.25
    10/1/2017 ,,,,, 0.06 ,,,,, 0.27 peak
    11/1/2017 ,,,,, 0.08 ,,,,, 0.24
    12/1/2017 ,,,,, 0.10 ,,,,, 0.17

    Note that demand side factors peak in Oct.

  31. Gravatar of Christian List Christian List
    21. October 2017 at 05:22

    I love this post and the last one. Can’t wait for your books.

    It’s the basics really, and you mentioned them before, but it’s always nice to see them framed in a slightly different angle, this way you always learn something new.

    I assume that we don’t even have to wait for your book about economic principles, because 95% of the information can be found in your blog posts already.

  32. Gravatar of Steve F Steve F
    21. October 2017 at 08:32

    Major Freedom,

    Believe it or not, I agree with your criticism. It really can be the case that in a free market of money, people would be accustomed in such a way that prices are not sticky. I have argued in the past that it is because central banks exist that a lot of monetarist stuff has to be done, but if central banks didn’t exist, we could do more of what I believe falls under Austrianism.

  33. Gravatar of Major.Freedom Major.Freedom
    21. October 2017 at 12:00

    Steve F:

    You are the hope.

  34. Gravatar of Matthew Waters Matthew Waters
    21. October 2017 at 12:12

    I should have said the first paragraph had those assumptions. Then I was confused when:

    1. The assumptions were relaxed.
    2. Demand causes merchants without expectations to increase prices.
    3. You shouldn’t think demand caused the prices to increase.

    I find that somewhat confusing. Demand seems like an extremely key intermediate variable. Expectations could get prices raised instantaneously or demand itself will raise the prices.

    Consequently, demand OR expectations of demand can change due to M or V. Constant velocity for M0 isn’t even approximately true.

  35. Gravatar of ProfPlum99 ProfPlum99
    22. October 2017 at 04:44

    To continue the thought experiment, what happens if a crate of PEOPLE washes up on shore?

    1) a crate of babies, who will eventually produce, but currently consume only?
    2) a crate of teenagers, who COULD produce, but laws/culture prevent their contribution?
    3) a crate of 20 somethings, who would like to produce, but business owners face minimum wages and a shortage of capital stock to employ them productively while the island Central Bank reacts to the price increase created by the outward shift in AD (mouths x quantity per mouth) by hiking interest rates to prevent price increases?
    4) a ship of pirates, who take all the teenagers away, dramatically reducing AD which the CB attempts to confront with lower rates?

    Ignoring obvious (in hindsight) demographic shifts and their impact on observed price increases and decreases is the source of much of what passes for “inflation”. Welcome to #4 (pirates and an overly accommodative CB) — natural outcome is low inflation, low V and high asset prices).

  36. Gravatar of Bob Bob
    22. October 2017 at 09:08

    There’s been studies made regarding price transference, and yes, even among the most uneducated, it happens pretty much immediately, as prices are the main transmission mechanism. Someone could know zero regarding economics, and be completely unaware of the future policy change, and they’ll change their prices anyway.

    It’s also very interesting to see experiments regarding understanding of abstract mathematics and the use of the very same concept in markets and daily life. People that find abstract math to be a brick wall but have their own retail businesses manage to make the right decisions that the abstract math would recommend: They don’t lack the numerical capacity, they just have it linked to their expertise.

  37. Gravatar of Tommy Dorsett Tommy Dorsett
    22. October 2017 at 13:14

    Scott – This might be your best post since you exploded onto the blogosphere in 2009.

  38. Gravatar of Carl Carl
    22. October 2017 at 20:56

    My attempt to answer Profplum99:
    1. Inflation. Demand was increased and supply was decreased as coconut farmers can spend less time tending to their trees because they are having to spend time watching babies.
    2. Inflation. See answer 1.
    3. Depression. See answer 1 plus throw in high interest rates to reduce investment.
    4. Nothing because the pirates took away the excess demand.

  39. Gravatar of Jose Jose
    23. October 2017 at 04:27

    Prof. Sumner, if you read sell side macro reports from investment banks you would pull some other thing out too, not only your hair…

    Phillips curve and the “credit channel” as they call it are all they talk about.

  40. Gravatar of ssumner ssumner
    23. October 2017 at 07:50

    Thanks Everyone.

    Steve, You said:

    “do you think that the Fed lowering the interest rate while not increasing the monetary base in 2007 — which you’ve said in the past created a money demand decline”

    I don’t think I ever said that. Lower rates raise Md.

    Benoit, You said:

    “So I guess my arguments all come down to the changes in demand and change in interest rates being, for most actors, the main source of information on changes in money supply. ”

    God help us if this is true, as interest rates are a horrible indicator of monetary policy.

    Mario, You said:

    “Wouldn’t it be more accurate to state that a change in inflation is evidence of an imbalance in the supply and demand of money?”

    No, it’s better to talk in terms of “changes” in S or D, not imbalances.

    Matthew, If prices rise 10% without X, and only 4% with X, then in what sense is X causing prices to rise?

    Bob, Excellent comment.

  41. Gravatar of Steve F Steve F
    23. October 2017 at 11:19

    Scott, I’m referring to our exchange here

    I said:

    “Scott, as you’ve noted in the past, the monetary base uncharacteristically did not grow during virtually all of 2007. During this time, the Fed lowered the nominal rate by about 125 basis points. If we show this on a money market graph (nominal interest rate on y axis and quantity of money on x axis), this would mean that when the Fed set the nominal rate lower without increasing the money supply, the nominal rate is below the equilibrium point, resulting in greater quantity of money demanded than quantity of money supplied and thus a shortage of money. Going off the statement in your opening paragraph, “As market interest rates fell (there was no Fed), the demand for gold increased. Because gold was the medium of account, this was a negative demand shock,” this suggests than in the scenario I described in the money market, the demand curve for money would shift leftward, resulting in a leftward shift in the AD curve on an AS/AD diagram.

    Is this correct? If not, what am I getting wrong?”

    And you responded with:

    “Steve, No, it’s not disequilibrium on the money S&D graph, it’s a decline in the demand for money.”

    I’m confused.

  42. Gravatar of ssumner ssumner
    23. October 2017 at 11:42

    Steve, My point is that the equilibrium interest rate fell because the demand for money shifted left, not because the Fed set the rate below equilibrium (as you claimed).

  43. Gravatar of Steve F Steve F
    23. October 2017 at 13:52

    Scott, am I correct in saying that you think the demand for money during 2007 shifted left due to the Fed’s stall in money growth? Which would mean that as the Fed lowered its benchmark rate, because Ms was not moving to the right, Md was moving to the left?

  44. Gravatar of Christian List Christian List
    23. October 2017 at 14:51

    @Steve F

    …shifted left due to the Fed’s stall in money growth?

    I assume it shifted left because (N)GDP expectations fell like a stone thrown out of a Boeing 747 at FL320?

  45. Gravatar of Matthew Waters Matthew Waters
    23. October 2017 at 15:18

    “Matthew, If prices rise 10% without X, and only 4% with X, then in what sense is X causing prices to rise?”

    Both cases have either higher demand OR expectations of higher demand. “X” seems to be the price stickiness which reduces price growth from 10% to 4%. Of course stickiness doesn’t increase prices.

    But demand or expectations of demand is a key intermediate step. Demand can change or be expected to change from exogenous changes in velocity, not just changes in monetary base.

  46. Gravatar of Mark Mark
    23. October 2017 at 18:27

    The last few psots have been comparatively clear, but I agree with those saying Prof. Sumner needs to write a book on all this (or refer me to one by someone else). It’d be much easier to go through than trying to piece things together from assorted blog posts.

  47. Gravatar of Steve F Steve F
    23. October 2017 at 19:27

    Christian, but why did NGDP expectations fall? The going explanation I thought around here was that money was that money supply growth had been slowing and reached a halt.

  48. Gravatar of Benjamin Cole Benjamin Cole
    24. October 2017 at 01:44

    “TOKYO — Foreign assets held by Japanese institutional and individual investors appear to have topped 1,000 trillion yen ($8.79 trillion) for the first time, according to Nikkei estimates. The amount has increased roughly 50% during the past five years and now is more than twice as much as the country’s gross domestic product.”


    What does this mean? We hear Japan is over-indebted, but they own 2x GDP in foreign assets?

    Also, the BoJ has been conducting QE and holding interest rates at zero. But if capital flows offshore, what does that mean?

  49. Gravatar of flow5 flow5
    24. October 2017 at 11:12

    “My point is that the equilibrium interest rate”

    There is not such thing as an equilibrium interest rate.

  50. Gravatar of Major.Freedom Major.Freedom
    24. October 2017 at 18:05

    It doesn’t look good for the Clinton criminal cabal.

    The Clinton campaign and the DNC paid for the fake “Piss” Russian Dossier that was used by Obama to spy on the Republican nominee for president.

    Of course if this was Trump campaign doing all of this you wouldn’t hear the end of it on this “centrist” haha blog.

    If you think that’s bad enough, it is even worse, because of what also happened after:

    1. Comey’s FBI continued to pay Steele.

    2. McCain was involved spreading the dossier – even sending his agent to London.

  51. Gravatar of Antoine Belgodere Antoine Belgodere
    25. October 2017 at 01:05

    Dear Scott,

    Just imagine the same story, but the guys who find the extra money don’t tell the others. Do you think it will create no inflation, or do you think after some time you will have the same inflation? The answer is obvious: more and more money in circulation will cause interest rate to fall and workers to work more initially. Then, with a tighter labor market, workers will start raising the price of their labor, and then the price of the goods they produce will rise also. So, at least when the extra money creation is unknown, tightness of labor market is a transmission mechanism.

    But, you are right, it is ultimately the extra money that creates inflation.

    Now, please, add just an extra feature to your story: suppose that the money is, in fact, a fiat money created on demand by a central bank at a price she chooses herself. How the hell could inflation come from extra money creation in this setting? The fed did not destroy any money in 2008.

  52. Gravatar of Postkey Postkey
    25. October 2017 at 02:12

    “Then another crate of Monopoly money unexpectedly washes up on the beach, doubling the money supply to $2 billion.”

    Assume a tin {can} opener?

  53. Gravatar of Major-Freedom Major-Freedom
    25. October 2017 at 04:01

    They know the pedo-rings are about to get busted. Hollywood, Bill Clinton, Epstein. It’s all about to explode, so they are cutting the Clintons loose in an attempt to save their own skins. The fact the WaPo reported on this is very telling. The criminal global satanic pedophile cabal is going to be revealed to the mass population, and there isn’t anything their lying and covering MSM can do about it.

    All of those who defended them will be tainted and smeared for eternity.

    You just watch.

  54. Gravatar of ssumner ssumner
    26. October 2017 at 07:53

    Steve, Yes.

    Matthew, Yes, but don’t mix up “demand” and “excess demand”

    Mark, I’m working on it.

    Antoine, You said:

    “Just imagine the same story, but the guys who find the extra money don’t tell the others. Do you think it will create no inflation, or do you think after some time you will have the same inflation? The answer is obvious: more and more money in circulation will cause interest rate to fall and workers to work more initially.”

    I agree that you’d end up with the same long run inflation either way. But it has nothing to do with interest rates falling or people working more. Extra work actually holds down inflation, and there are no interest rates in my island economy.

    Not sure what you mean by creating money “on demand”

  55. Gravatar of OssiL OssiL
    27. October 2017 at 11:22

    What about savings?

    Let’s say the island people are a prudent folk and are foremost hoping to have an extra $10000 stashed away for peace of mind and to pass on to the next generation and so forth. Or $20000.

    Now the $1 billion crate arrives and the people proceed to bury the money in their backyards.

    What happened?

  56. Gravatar of Antoine Belgodere Antoine Belgodere
    27. October 2017 at 12:26

    Scott, if you agree inflation will be the same in both situations, you need to figure out how inflation would come out in the second case. I am pretty sure you will come to the conclusion that some people will initially work more, and then increase their prices, which is the Phillips curve. On a second round, the expected inflation will be higher, so the Phillips curve will be shifted up, and so on. This is nothing but a very Friedmanian theory of aggregate supply!

  57. Gravatar of ssumner ssumner
    29. October 2017 at 15:35

    OssiL, Prices double. Saving has nothing to do with it.

    Antoine, I don’t follow your point.

Leave a Reply